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Why Do CMOs Exist?
CMOs play an important role in the world of pharmaceuticals. The pharmaceutical industry is one of the most complex on Earth, maybe together with the semiconductor industry. Not only do you need to innovate constantly, but you also need to manufacture a flawless product and then market it in a very tight regulatory environment.
Innovation is the focus for smaller companies, as a smaller and more agile company can bring innovation that larger companies might struggle to achieve. A common practice is licensing these discoveries to larger pharmaceutical companies for commercialization.
But if a growing biotech or pharmaceutical company wants to handle it alone, it must build up a complex chemical or biological production line for its innovative product. This can be daunting, as producing a custom small amount for testing in a lab is entirely different from mass-producing drugs.
For this reason, an entire industry called Contract Manufacturing Organization (CMO) exists to provide such manufacturing as a service.
Outsourcing Pharmaceutical Production
CMOs bring a wide array of advantages to the table compared to doing the production independently:
- Expertise in GMP (Good Manufacturing Practices) is required for drug manufacturing.
- Existing facilities, reducing delays of production.
- The economy of scale reduces the cost per unit.
- Spare capacity, allowing for more flexible production volume without risking stranded assets or supply shortages.
Because of all these advantages, CMOs are a valuable and stable part of the pharmaceutical supply chain. Most will specialize in specific segments, like one chemical or biological drug type, a dedicated geographical zone, etc.
Once a production line is established, it is also a very “sticky” business, as any change in production method, site, etc… would require a whole new set of checkups, controls, and testing by the regulatory authorities, like the FDA.
It can also be a way for large pharmaceutical companies to offload legacy manufacturing lines in segments they are exiting.
A slightly different business model is CDMO: Contract Development and Manufacturing Organization. On top of manufacturing, CDMOs provide help for R&D, clinical trials, analyses, or post-marketing monitoring (checking for quality and possible unexpected secondary effects after approval and commercialization).
One advantage of using CDMO over CMOs is that the production line used in the clinical trials will be the same as for the commercialized product, bringing extra safety and speed to the process.
Some companies will provide both CMOs and CDMO services.
Top 5 Contract Manufacturing Organizations (CMOs) and CDMO Stocks
Lonza is one of the world's largest CMOs/CDMOs and the largest one that is publicly traded.
It is active in all main 4 categories of pharmaceutical treatments: biologics, small molecules, cells, and capsules/ingredients.
Thanks to its main location in Switzerland, most Lonza clients are in the EMEA regions (Europe, Middle-East, Africa) but with a significant portion in the Americas. The majority are smaller firms, with large pharma making just 40% of the total.
The company invested CHF2B in capex in 2022, with the majority of this capacity in biologics. Lonza generated CHF6.2B in sales in 2022, growing them by 15.1% year-to-year. The ROIC (Return On Invested Capital) is rather high for a capex-heavy company, at 11.4%. The company distributes dividends, which have almost doubled since 2013, and bought back CHF2B worth of shares in 2022.
Thanks to its unique size and expertise, Lonza will likely become a dominant CMO/CDMO in the biologics market. This is a stock for investors looking for exposure to the pharmaceutical manufacturing sector at large and unwilling to take chances with smaller competitors.
Wuxi is a large Chinese CMO and a pioneer in the model of CRDMO, adding research services to the classic CDMO offers. This tends to blur a little the line between CDMOs and full-stack pharmaceutical companies. It can also provide a steadier pipeline of contracts, from the research stage to the commercial scale manufacturing.
The CRDMO model recently got validated by signing a contract with GSK for antibodies worth up to $1.4B in royalties if all key milestones are reached.
The company expects strong growth of its activities in the short-term, thanks to 21 manufacturing projects, which could generate up to $2B in revenues.
Behind the company's growth is its success in complying with stringent inspections and regulations, with 14 certified facilities in 2022 from just 2 in 2018. Some of the new facilities were acquired, notably 2 in Germany from Bayer and one in China from Pfizer.
Most of the company revenues are from North America (54%), with the rest from China and Europe, with Europe having experienced the quickest relative growth. Projects have grown steadily, from 103 in 2016 to 588 in 2022.
For the first time, the company achieved positive free cash flow in 2022 and a record of RMB 3.4B ($438M).
Overall, Wuxi Biologics is focused on a high-growth segment, biologics, the same identified as a priority by leaders like Lonza. Potential investors will want to fully understand the advantages and limitations of the CRDMO business model. They will also look at the future expansion into more European projects and maybe other Asian countries.
Dr. Reddy's is an Indian CMO with manufacturing facilities in India, China, Europe, and the USA. It is active in manufacturing generics, active ingredients, and proprietary products (drugs owned by a specific company in exclusivity).
Most revenues come from the generics department, with $2.3B of the $2.8B total revenues. The largest market is the USA, followed by India and emerging markets.
The company has been growing revenues by 13% year-to-year and profit after taxes by 37%.
Dr Reddy's is focused on a “boring” but profitable segment, generics, where it leverages its low-cost advantage from operating in India and uses it to generate comfortable margins.
This is more of a stock for investors looking for a slow and steady approach, focusing on capital efficiency and stable revenues, as the generic markets tend to have much lower competition and changes.
In that context, a low P/E ratio might seem justified but also indicate undervaluation as the company is growing strongly.
This CDMO is active in most segments, including biologics and cells, and also oral tablets, clinical supplies, and consumer products. The company mostly focused on the US and biologics and had large COVID-related activities in 2022 (27% of all products). It recently expanded its bioreactor capacity for biologics production. It has spent a lot on capital expenditure recently, at 13.8-17.2% of revenues in 2020-2022.
Two key partners are Moderna, for producing biological drugs, and Sarepta, to help them develop novel cell therapies.
Catalent sees its addressable market at $72B in 2023 and growing to $100B in 2026. It targets growth of its activities at a total of 8-12%, carried by biologics at 10-15% growth but weighted down by pharma and consumer health at 6-10%.
The company has been deleveraging rapidly, bringing its net debt to long-term EBITDA at 3.2x from 4.4x in 2019. Its stock price suffered when it gave a warning of a degraded forecast for its Q3 2023 and postponed the announcement of the quarterly results.
This makes Catalent a potentially interesting turnaround stock for investors who risk high volatility. Due to its smaller size, the company will be highly exposed to the successes or failures of its key partners in developing novel treatments, so investors in Catalent will also want to learn more about Moderna and Sarepta. (we cover Moderna (MRNA) in “The Next Application for mRNA Technology: Cancer Therapies” and mentioned Sarepta (SRPT) in “RNA Based Therapeutics are Gaining Traction: What Are Investors Options?”).
Siegfried can currently supply 200 out of the 1,500 API (active pharmaceutical ingredients) approved by the FDA. This is used by 500 different customers, and 1 billion people come into contact with Sigfried products every year.
The company was also active in Covid vaccine manufacturing, having made 100 million doses in total.
The company focuses more on providing ingredients, components, and services to the pharmaceutical industry than full drugs and treatment. This includes supplying API, filling vials and syringes, or assembling the product into pills.
Sigfried has recently expanded its activity in cell therapies by acquiring DiNAMIQS for “mid-double-digit million Swiss Francs.” It also has launched the construction of a new CHF 100 million factory in Germany.
In March 2023, it has also finished integrating 2 manufacturing sites in Spain, which it had acquired in 2021 from Novartis. It previously acquired 3 production sites from BASF in 2015.
The company has grown its revenues by 15% year-to-year and core net profits by 34.1%.
Even with its presence in biologics and other complex molecules, Siegfried's business model is more akin to the one of a chemical company. Instead of taking on the entirety of the manufacturing process like a classic CMO, it provides at scale the ingredients and/or specific services that other companies might need or be less efficient at doing themselves.
This might expose it to energy cost inflation in Europe, although to a lesser extent than other chemical companies not focused on pharmaceutics.
It also makes Siegfried an essential component in the pharmaceutical supply chain. In that context, it is notable that the company increased its inventory in 2022 to de-risk potential supply shocks, a needed move demonstrated by the pandemic.
The company is clearly aiming for aggressive growth and has been trading at a relatively low cost. It should continue to grow and perform well as long as pharmaceutical companies seek to evolve into more asset-light business models, re-centering R&D and/or marketing instead of manufacturing.